Growth going in to 2019
In 2018, risk assets began to reprice for a more uncertain future, and many assets and equity indices produced negative returns. Economic data indicated a world economy continuing to grow, but at a slowing pace. The IMF estimate that global growth will fall from 3.7% in 2018 to around 3.5% in 2019, with emerging markets picking up the baton from a slowdown in developed markets. We do not believe economies will fall into recession this year, but the risks appear skewed to the downside overall, not least until we get some clarity on whether the nascent trade war between the US and China/others will escalate in 2019.
Politics set to generate plenty of headlines
Political uncertainty continues to undermine sentiment, and the theme of populism is likely to appear many times throughout 2019. Geopolitical risks remain elevated: we expect tensions between the US and China to continue, and instability in the Middle East remains an almost permanent threat, heightened by the current US administration’s desire to see Iran’s power diminish.
Don’t mention the “B” word!
Brexit will continue to dominate domestic headlines. Any short-term outcome that avoids a ‘cliff-edge’ exit on 29 March would be welcome. Second-guessing what comes next is near impossible, though it’s clear sterling will remain very volatile over the coming weeks. The uncertainty will continue to weigh on the UK economy, and with Europe (our biggest trading partner) also slowing, the UK economy faces significant headwinds over the coming months.
Central banks will continue to influence sentiment through policy and language
Major central banks will likely continue to ‘normalise’ policy after almost a decade of near-free money. The US Federal Reserve (Fed) is the key bank to watch for further rate rises, while economic data will be important given that the Fed is shifting to a more flexible and ‘data dependent’ attitude. The Bank of England is also keen to tighten policy but will have to wait for more certainty around Brexit. Although the European Central Bank (ECB) has brought quantitative easing to an end, tightening seems some way away. We may see a technical rate hike at some point, however, as the ECB looks to support banks impacted by years of negative interest rates. The language from Mario Draghi and his incoming replacement will be scrutinised. The Bank of Japan is still behind its inflation targets, so we do not expect any significant policy shifts for now. Emerging market central banks are in reasonable shape to cut rates should growth ease.
Headwinds greater than tailwinds
Investors will likely have to work harder for their returns this year as the boost from ultra-loose monetary policies fades while other headwinds increase. Aside from political uncertainty, earnings growth looks set to slow at a time when valuations cannot be described as ‘cheap’ and companies are sat on significant amounts of debt. As the costs of servicing debt rise over 2019 and the coming years, rising interest payments will likely impact economic prospects.
We enter 2019 with relative caution – we see opportunities for stock-pickers and believe positive returns are possible, but want to manage investors’ expectations. We are neutral on equities but could go underweight and instead increase our positioning in cash and absolute return portfolios. Fixed income remains an underweight, though government bonds may be more interesting if the global slowdown narrative gathers momentum; this poses risks for high yield and some investment grade bonds. We have no real conviction on what happens next in the UK and remain broadly neutral given the binary risks to the upside and downside. Europe continues to be a mild underweight and we remain very slightly underweight the US, preferring Asia, Japan and emerging markets. An easing in the trade rhetoric, and possibly some stimulus in China, would add to our conviction, as would any easing in the trade-weighted value of the US dollar. In property, we continue to prefer assets that avoid the liquidity mismatch between open-ended funds and illiquid assets. We prefer smaller and closed-ended property funds, many of which have a significant amount of inflation-linked assets.
Investor sentiment going into 2019 appears to be broadly bearish, and if there is better news on growth, politics and trade, we may see sentiment improve swiftly. But investors might have to be patient as clarity on some of these issues will take some time. Many of the potential political and economic outcomes are near impossible to predict, so we will continue to stick to our ‘low-ego’ asset allocation approach and try not to spend too long second-guessing the actions of the world’s politicians and central bankers. We will stick with what we know best – picking fund managers we believe can navigate the relatively choppy waters ahead.